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Restructuring Trends

Waste not want not: the changing face of the UK waste sector

Landfill in the UK is in steep structural decline and the build out of alternative waste treatment infrastructure is progressing apace (although new technologies have not always delivered as promised). Depressed prices for recycling material and the devaluation of the pound have increased margin pressure in the industry and the market environment remains challenging. Brexit has made life tougher for waste exporters and the medium-term policy outlook remains uncertain. Further financial difficulties and M&A activity can be expected as sector consolidation continues.

Bright spots…

After several years of decline, UK waste arising from households is increasing, supported by the economy’s return to growth following the last recession. This trend is expected to continue, underpinned by rising population and household growth.

The fortunes of some previously restructured waste companies have also improved. Biffa, whose high profile restructuring was led by PwC, is a good example of a successful turnaround, recently announcing its return to the London stock exchange with a £450m IPO. Biffa is pursuing a targeted acquisition strategy to improve the efficiency of its collections business.

The build out of UK waste infrastructure also continues apace. In 2015 an estimated 11 million tonnes per annum (mtpa) of residual waste treatment capacity was operational with a further 5 mtpa of capacity under construction[1]. The majority of this capacity has been developed under local authority Private Finance Initiative (PFI) schemes, but an increasing number of “merchant” projects are now succeeding in securing finance.

The export of Refuse Derived Fuel (RDF) to mainland European and Scandinavian countries with excess treatment capacity has also grown strongly from 250kt in 2011 to 3.4mt in 2015. This combination of new domestic and export capacity will provide improved alternative disposal options and should ultimately drive down the costs of disposal, but exposes waste operators to a different set of business risks including currency and logistic considerations.

Local Authority Collected Waste Generated

…in a tough market environment

Margins are under continuing pressure in both the highly competitive Industrial and Commercial collection sector and the Municipal collection subsector. Councils are increasingly turning to larger joint procurements, or transitioning to “in-house” or “arms’ length” delivery models to reduce costs and meet strained budgets.

Recycling prices remain relatively depressed with no significant recovery expected. This could result in margin pressure for waste collectors, which may, particularly in the municipal market, have guaranteed recyclate value to their customers under longer term contracts. Several contractors have sought to extricate themselves from onerous municipal contracts with varying degrees of success.

Power prices are low compared with historical levels, negatively impacting Energy from Waste (EfW) providers and landfill gas operators (LFG) (a traditional cash cow for many integrated waste businesses). This position was exacerbated by the removal of the exemption to pay climate change levies for renewable generators in 2015 and could be further affected by Ofgem’s current review into embedded benefits, a material revenue line for EfW and LFG operations.

Scrap Ferrous Prices

Source: letsrecycle.com

Policy uncertainty

The Brexit vote has created uncertainty about the future direction of UK waste policy, which has previously been driven by the EU.

In the near term, existing environmental legislation is expected to remain in place, but the UK government’s medium to long term vision for the waste management sector post-Brexit is uncertain.

In the short term, RDF exporters have been negatively impacted by sterling’s weakness since the Brexit vote.

Exporters pay their European customers to take RDF waste products and sterling’s depreciation has increased the cost of these euro-denominated contracts, which they are unable to pass back up the supply chain.

In addition, the growth in the RDF export market is stabilising as capacity is being reached in importing countries. The impact of these factors will become clearer as existing contracts unwind.

Development of alternative waste treatment facilities remains key

The UK’s goal of landfill diversion, through the implementation of an escalating Landfill Tax, has led to the development of a number of large infrastructure projects for alternative waste treatment facilities, many of which have been developed under Private Finance Initiative (PFI) contracts from local authorities.

The majority of these large waste treatment facilities have utilised proven technologies such as “mass burn” Energy from Waste (EfW), but a number have used alternative technologies such as Mechanical Biological Treatment (MBT) or gasification.

Whilst most of these projects have been relatively successful, some have faced delays and challenges primarily driven by difficulties with technology, such as the closure of waste treatment facilities in Lancashire, the administration of New Earth Solutions, and the discontinued Air Products’ Tees Valley development. These discontinued projects have proved very costly, for example, the construction cost of the Lancashire waste facilities was £250m[2] and the write-off from discontinued development of Air Products’ Tees Valley development was estimated at between £630m-£700m[3].

Despite these challenges new projects continue to be approved and there is a consensus among the larger waste management companies that additional capacity is needed.

Future trends

A number of underlying trends will shape the market in the immediate future, including:

Further consolidation

Larger waste management companies are better positioned to provide a full service offering. They are more efficient at processing waste and have greater (and more price certain) access to effective treatment capacity. Large integrated trade players are likely to continue to focus on strategic acquisitions of smaller, regional companies, such as Biffa’s acquisition of Cory Environmental’s waste collection business in June 2016 and the regional collection and processing business, Blakeley’s in September 2016.

The wider European market shows evidence of growing Chinese and other overseas investor interest in the sector, such as China’s Firion Investments’ acquisition of Spain’s Urbaser SA and Beijing Enterprise Holdings’ acquisition of Germany-based EEW. We expect this interest to flow through to the UK market as UK treatment infrastructure assets mature and transaction volumes increase.

Scale matters

Smaller and mid-market waste companies without critical mass, or a particularly strong regional position are expected to face a difficult environment. Companies operating a business model of collection services, basic pre-treatment and export out of the UK are more likely to suffer in the current trading environment, in light of strong competition for customers, escalating RDF export costs and continuing low recyclate values.

Landfill decline is terminal

Landfill Tax continues to increase with RPI and tonnage continues to be lost to new domestic treatment capacity and the export market. Accelerating closure dates will in turn accelerate capital expenditure spend for landfill operators as capping and remediation work begins following site closure. Whilst landfill owners with strategic locations may be better positioned in the near-term, in the long-term, the outlook for landfill has not changed. We expect an increasing number of waste businesses to seek to exit landfill as “landfill consolidators” emerge.

New technology

While the pipeline of local authority PFI contracts has slowed to a trickle, both large waste companies and smaller developers believe additional capacity is required and continue to develop new facilities on a “merchant” basis. Some of these projects use less proven, gasification-based technologies. Given the number of recent high-profile and costly project failures, careful consideration needs to be given to technology risks when evaluating new infrastructure developments.

Conclusion

Tough competition, local government budget constraints and low recyclate prices are keeping sector margins under pressure while RDF exporters face a tougher market post-Brexit and the unproven nature of new technologies adds to the risk of infrastructure development. Against this backdrop we expect weaker operators will face on-going difficulties and the larger integrated companies will continue to act as consolidators.